Savola Group sees recovery next year

SAVOLA has delivered another quarter of below par performance due to sustained pressure in both its key segments of food (adverse currency movements and high competition) and retail (Pandati investments not yielding results, higher opex due to store roll-outs and setting up of new distribution center in western region). Further, consolidated gross margin has shrunk y-o-y in both food and retail segments according to the company’s earnings release, which stands in contrast to gross margin expansion witnessed by Al Othaim. Lower gross profit was negated by lower than expected SG&A expenses (though higher than last year) and higher income from associates (approx. 30 mn more than our estimate), resulting in operating income coming in-line with our estimate. However, higher than estimated financial charges and higher losses in USCE (due to currency impact) led to miss at net income level. We factor in lower gross margin profile for the next couple of years and higher currency losses for FY16. Based on our revised estimates, our target price stands at SR43 per share (SAR48 previously) and we continue to maintain Overweight rating. We believe increased competition and currency devaluation in key international markets will continue to impact the food segment (46% of revenue in Q1) this year, but should stabilize in 2017. 40% of food segment revenue (Egypt: 21%, Iran: 15%, Turkey: 4%, as at Q1 2016) is exposed to geographies which have witnessed currency pressures. Retail segment (54% of revenue in Q1) was likely impacted by sustained underperformance of Pandati stores (51 stores, with lesser traffic and unfavorable locations, were closed down in Q1 2016 vs. 282 stores at the end of 2015). However, over the medium to long term, Savola’s retail segment is well positioned to benefit from continued shift toward modern retail (hyper and super market formats). Based on the trends in last 2 quarters, we factor in lower gross margin profile for the next couple of years and build for higher currency losses for FY16 (mainly due to depreciation of Egyptian pound). However, we expect earnings to bottom this year as majority impact from restructuring in retail segment, USCE subsidiary (classified as discontinued operations) and currency depreciation would be behind. We expect earnings to stage a recovery from 2017. Our revised target price stands at SR43 per share (SR48 previously) and we continue to maintain Overweight rating.